Cloud computing has given software companies a chance to make all sorts of different business functions more efficient for their clients, with virtual resources available to avoid the cost of having to set up dedicated IT resources on-site. Ultimate Software Group (NASDAQ:ULTI) has been extremely successful at attracting customers looking for ways to move their human-resources functions into the cloud, and coming into Tuesday afternoon's second-quarter financial report, Ultimate Software investors had seen the stock climb to all-time highs as a result of the company's success. With its latest financials, Ultimate Software gave its proponents more arguments in its favor, with solid growth that exceeded expectations. Let's take a closer look at Ultimate Software and what its recent performance tells us about its future.
Ultimate Software soars into the cloud
Ultimate Software's second-quarter results kept its streak of solid performance alive. Sales for the quarter jumped 21% to $147.2 million, hitting a new record and exceeding the 20% growth rate that investors had expected to see. Recurring revenue climbed at an even faster rate of 22%, matching its performance from the first quarter, and after excluding stock-based compensation and other extraordinary items, adjusted earnings of $0.62 per share were up 35% from the year-ago quarter and topped the consensus estimate by $0.07 per share.
The importance of recurring revenue to Ultimate's overall results continues to grow. During the second quarter, revenue from services rose by just 15%, falling behind the growth in the much larger recurring category. The services business actually has negative gross margins, and so Ultimate Software has little interest in stressing its growth over that of the high-margin recurring revenue segment. Licensing revenue dried up entirely during the quarter.
One challenge that Ultimate Software faces, though, is on the cost side of the equation. Sales and marketing costs climbed by a third, and general and administrative expenses were up a whopping 64% from year-ago figures. That crimped GAAP net income, although many of the cost increases came from a doubling in stock-based compensation for the sales and market area and a more than 150% rise in overhead expense resulting from equity-based pay.
Still, CEO and founder Scott Scherr was happy about Ultimate's accomplishments, noting that "we are honored that third parties have recognized our achievement in recent months" and listing a number of high rankings in popular publications. At the same time, Scherr said that "we executed in all aeras of our 2015 second-quarter plan, and these results position us well to achieve our 2015 and future goals."
Can Ultimate Software keep its growth engines revving high?
Ultimate Software also provided solid guidance for the current quarter and the remainder of the year. For the third quarter, Ultimate expects revenue of around $156 million, which is in line with what most investors expect, and recurring revenue should come in at about $132 million. Ultimate reiterated its full-year 2015 guidance for total revenue growth of 22% and recurring revenue gains of 23%. For both periods, an adjusted operating margin of 20% is where Ultimate would like to land to support continuing growth.
Ultimate has reason to be optimistic. The company said that it managed to keep its customer retention rate above the 96% mark over the past 12 months, and that's a big key to the success of its recurring revenue business model.
Ultimate Software has continued to invest in itself as well, with stock repurchases accelerating during the quarter. Ultimate bought back more than 185,000 shares for $30.7 million during the quarter, and that doesn't include another 65,000 shares the company repurchased to deal with employee tax-withholding obligations. The stock repurchase plan still authorizes future purchases of nearly 600,000 more shares.
Investors didn't immediately react to the news from Ultimate Software, sending the stock slightly lower in the first half-hour of after-hours trading following the announcement after posting a solid 3% gain during the regular trading session. So far, though, Ultimate is giving investors exactly what they want, and the company's ability to keep growing at a consistent rate could continue to send its stock skyward as long as its positive trends last.
Dan Caplinger has no position in any stocks mentioned. The Motley Fool recommends Ultimate Software Group. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.